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The State Could Have Collected Millions in Additional Revenue Had CDTFA Used More Accurate Information in Its Tax Rate Calculation
As the Introduction describes, CDTFA must annually calculate the tax rate for other tobacco products based on the tax rate applied to cigarettes. To do so, it calculates the wholesale cost of cigarettes, which requires two pieces of information: the average manufacturer price of cigarettes and the wholesale markup rate. As Figure 3 in the Introduction shows, in fiscal year 2018–19, CDTFA used an average manufacturer price of $5.06 per pack of 20 cigarettes and a wholesale markup 30 cents, which is 6 percent of the average manufacturer price. However, CDTFA used higher values than warranted for both components. As we describe in the Introduction, if the wholesale cost used in the calculation increases, the tax rate for other tobacco products decreases.
Although CDTFA’s deputy director of its Business Tax and Fee Division (deputy director) stated that the department uses the best available, most reliable, and most current data when determining cigarettes’ average wholesale cost, we found that the data it has used were incomplete and that better data were readily available. When calculating the tax rate for other tobacco products, CDTFA chose to base the average manufacturer price of cigarettes on the prices of premium cigarettes only, ignoring the prices of less costly cigarettes. In addition, it used a wholesale markup rate that multiple sources indicate is too high. Had CDTFA used more accurate amounts for both the average manufacturer price and the wholesale markup rate in its calculation, it would have collected $6.3 million in additional tax revenue during fiscal year 2018–19 alone. This additional revenue would have helped to fund programs to reduce tobacco use and improve the health of Californians.
CDTFA Excluded the Prices of Discount and Deep‑Discount Cigarettes When Calculating the Average Manufacturer Wholesale Price
CDTFA annually obtains the average manufacturer wholesale price of cigarettes from the Tobacco Merchants Association (Merchants Association), a tobacco industry trade association. The Merchants Association publishes the average manufacturer wholesale prices for three classes of cigarettes: premium, discount, and deep‑discount. Despite the significant impact of the manufacturers’ wholesale price of cigarettes on the tax rate for other tobacco products, CDTFA has assumed that the highest‑priced class of cigarettes—premium cigarettes—represents the average manufacturer wholesale price for all cigarettes, ignoring less expensive discount and deep‑discount cigarettes.
We reviewed cigarette industry market research and found that premium cigarettes represent only about 83 percent of cigarettes sold in the United States and that discount and deep‑discount brands constitute the remainder.Cigarettes in the US, July 2020, Euromonitor International, an independent market research provider. If CDTFA had included discount and deep‑discount cigarettes in its calculation of the wholesale cost of cigarettes, it would have arrived at a lower average manufacturer wholesale price, thus increasing the tax rate it applied to other tobacco products, as Figure 5 shows. Although their exclusion increased the average manufacturer wholesale price of cigarettes by only 2 cents in fiscal year 2018–19, that small shift cost the State $1.3 million in lost other tobacco products tax revenue during that fiscal year alone.
CDTFA Reduced the Tax Rate on Other Tobacco Products When It Excluded the Sales of Discount and Deep‑Discount Cigarettes
Source: CDTFA’s fiscal year 2018–19 other tobacco products tax calculation, CDTFA tobacco sales data, average manufacturer prices reported by the Merchants Association, number of cigarettes sold by brand reported by Euromonitor International, and auditor analysis.
CDTFA’s deputy director explained that CDTFA has relied on the average manufacturer wholesale price of only premium cigarettes because it did not have a reliable source of information for determining the various classes of cigarettes’ proportion of total sales. She asserted that CDTFA would have to make assumptions about these proportions and that the calculation would not be simple or reliable. However, for a fee of less than $1,000, we were able to purchase a tobacco industry market analysis that included information on the quantity of cigarettes sold by brand for each of the previous 10 years. Using this information, we calculated a weighted average manufacturer wholesale price of cigarettes that incorporated premium, discount, and deep‑discount cigarettes by multiplying the proportion of cigarettes each brand sold by the price of the cigarette class that the Merchants Association assigned to that brand. Unless CDTFA incorporates a similar process into its rate calculation, it will consistently overstate the wholesale price of cigarettes and will therefore continue to undercollect tobacco taxes meant to help Californians stop smoking and live healthier lives.
CDTFA’s Use of a Seemingly Arbitrary Figure for the Wholesale Markup Rate Has Further Reduced Tax Revenue From Other Tobacco Products
Although it obtains updated information on the wholesale manufacturer price of cigarettes from the Merchants Association each year, CDTFA has estimated the wholesale markup rate to be 6 percent in its calculations for more than a decade—first for Propositions 10 and 99 taxes, and then for Proposition 56 taxes when it began collecting them in 2017. However, this markup rate is higher than warranted, further reducing the tax rate on other tobacco products. CDTFA’s deputy director was unable to explain how it first estimated 6 percent and stated that before our review, it had not prioritized obtaining more current information. According to the deputy director, the staff members who originally estimated the 6 percent rate no longer work for CDTFA. Although the methodology incorporating the 6 percent was adopted in a public meeting in 2009, she stated that she worked in an unrelated part of the agency at the time and she does not know how they made this determination. In the absence of evidence or a rationale, CDTFA’s use of 6 percent appears to be arbitrary.
Studies of Wholesale Markup Rates CDTFA Obtained in Response to This Audit
State Cigarette Minimum Price Laws—
United States, 2009
- Source: Centers for Disease Control and Prevention
- Markups range: 2 percent to 6.5 percent
- Average markup rate: 4.1 percent
Tobacco Product Pricing Laws: A State‑by‑State Analysis, 2015 (Published in 2016)
- Source: University of Illinois at Chicago
- Markups range: 2 percent to 6 percent
- Average markup rate: 3.7 percent
Tobacco and Vapor Tax Guide—July 2020 (Premium Price Sector)
- Source: Merchants Association
- Markups range: 2 percent to 5.75 percent
- Average markup rate: 3.6 percent
Source: As noted in text.
After we brought our concern to CDTFA’s attention, it obtained information that it asserted justifies a 6 percent markup rate. Specifically, CDTFA offered two primary bases to support its markup rate: a calculation and estimates from three studies. However, we identified significant flaws with both of these bases. First, CDTFA’s calculation combined information from different sources to reach a markup rate in excess of 6 percent. However, combining information from these sources is not logical. For example, although one piece of information that CDTFA used relates solely to cigarettes, another piece of information averages the markups for cigarettes, other tobacco, and nontobacco products, despite the fact that the source from which CDTFA obtained these data explicitly states that markups are generally higher for other tobacco products. Second, CDTFA provided three studies that it asserted support the rate that it calculated. However, as the text box shows, we found that the studies do not consistently support a markup rate of 6 percent and that one of the studies is more than 10 years old.
Information from a variety of sources we analyzed indicates that the 6 percent markup rate is too high. A 2020 tobacco industry analysis reported that wholesale markup rates decreased considerably in 2016 and 2017, in part because of declining cigarette consumption.Cigarette and Tobacco Products Wholesaling in the US, February 2020, IBISWorld Inc. This report also estimated that the average markup would be slightly more than 2 percent in 2020. In addition, the Merchants Association has compiled information on the wholesale markup rates that 25 states have established in law. Because California is not included in the Merchants Association’s information, we analyzed the data on the states that are included. As of July 1, 2020, the average of those rates was less than 4 percent, and none of the states had a wholesale markup rate of 6 percent or more. Finally, the 2019 financial statements of two large cigarette distributors—one of which is the fourth largest distributor of cigarettes—indicate that their wholesale markup rates on cigarettes were both less than 2 percent.
Based on the information we reviewed, CDTFA should have used a wholesale markup rate between 2 percent and 4 percent. As Figure 6 shows, had CDTFA used a wholesale markup rate of 4 percent—the more conservative number—we estimate that it would have collected an additional $5 million in tobacco tax revenue during fiscal year 2018–19 alone. After we brought this issue to CDTFA’s attention, the deputy director stated that in the future it could use information gathered by its research and statistics group to determine the appropriate markup rate; however, CDTFA’s failure to proactively update the markup rate has already cost the State millions of dollars in lost revenue. The State Board of Equalization, the agency that administered tobacco taxes in 2009, estimated at that time that it would cost about $35,000 annually to determine the wholesale costs of cigarettes by surveying tobacco industry companies. According to CDTFA’s deputy director, the State Board of Equalization instructed staff not to periodically review the markup rate. However, in comparison to the millions of dollars in additional revenue that would have resulted from the use of more accurate tax rates, the price of obtaining this information seems reasonable.
CDTFA Would Have Collected Millions in Additional Revenue if It Had Used a More Accurate Wholesale Markup Rate to Calculate the Other Tobacco Products Tax Rate for Fiscal Year 2018–19
Source: CDTFA’s fiscal year 2018–19 other tobacco products tax calculation, CDTFA tobacco sales data, and auditor analysis.
If CDTFA Had Accurately Calculated the Cigarette Wholesale Cost, the State Could Have Provided At Least an Additional $6.3 Million Annually to Improving the Lives of Californians
Although the deputy director described several reasons for CDTFA’s approach to calculating the average wholesale cost of cigarettes, we question its conclusions. For example, she stated that CDTFA bases its calculation on minimal estimates and assumptions, which is necessary for it to stand up to scrutiny in court. However, CDTFA’s calculation incorporates both estimates and assumptions. Not only did it estimate that the wholesale markup rate was 6 percent, it cannot explain how it arrived at this estimate. Further, for the purposes of this calculation, it assumed that all cigarettes sold are premium cigarettes, despite market research showing otherwise. If CDTFA based its calculation on more accurate information instead of on estimates and assumptions, it would have a more logical basis for defending that calculation. Further, CDTFA could incorporate more accurate information into the calculation without dramatically increasing its complexity. Although consistently adopting assumptions that minimize taxes on other tobacco products may reduce the likelihood of litigation from the tobacco industry, it also reduces the revenue resulting from that tax.
Had CDTFA used more accurate figures for both the average manufacturer price of cigarettes and the wholesale markup rate, it would have increased the tax revenue the State collected under Proposition 56 during fiscal year 2018–19 by more than $3.7 million and the tax revenue it collected under Propositions 99 and 10 and the other distributor taxes by approximately $2.6 million. Although this represents a small proportion of the overall tobacco tax revenue the State collects, it could have used this additional $6.3 million for programs designed to reduce tobacco use and improve the health of Californians, as Figure 7 shows. For example, the Tobacco Control Program that Public Health administers would have received an additional $412,000, School Programs to Prevent and Reduce Tobacco and Nicotine Use that Education administers would have received an additional $73,000, and the 12 Proposition 56 programs that Health Care Services administers would have received an additional $3 million.
Had CDTFA Used Accurate Numbers in Its Calculations, It Would Have Provided Millions in Additional Funds to Support the Health of Californians (Fiscal Year 2018–19)
Source: State law, CDTFA’s fiscal year 2018–19 other tobacco products tax calculation, CDTFA’s tobacco sales data, average manufacturer prices reported by the Merchants Association, number of cigarettes sold by brand reported by Euromonitor International, Health Care Services’ internal budget and expenditure documents, and auditor analysis.
* Figure not exact due to rounding.
Some State Agencies Have Not Established Adequate Controls Over Their Distribution of Proposition 56 Funds
Although state law establishes requirements for the use of Proposition 56 funds, some of the state agencies that receive this money have not implemented sufficient safeguards to ensure that they are distributing the funds for their intended purposes. For example, state law requires Justice to award its Tobacco Grant Program funds for law enforcement efforts to reduce the illegal sales of tobacco products, particularly illegal sales to minors. However, in fiscal years 2017–18 and 2018–19, Justice awarded funds that were not used exclusively for activities that aligned with these requirements. The law also allocates funds to Health Care Services to pay for the student loans of physicians and dentists who provide services to California Medical Assistance Program (Medi‑Cal) recipients.California participates in the federal Medicaid program through Medi‑Cal. Health Care Services administers Medi‑Cal through an agreement with the federal Centers for Medicare and Medicaid Services. This program is to prioritize, in part, underserved parts of the State. However, Health Care Services has not ensured that the grantees it selects are located in geographic areas with provider shortages, undermining one of the program’s priorities.
Further, some state agencies had not established processes to monitor whether the grantees to whom they award Proposition 56 funds spend those funds appropriately. For example, Health Care Services has not established a procedure to verify whether health care professionals continue to treat Medi‑Cal patients after it begins paying off their student loans. By failing to establish adequate safeguards over Proposition 56 funds, the agencies have not advanced the purposes established in law or maximized the benefits the funds provide.
Some State Agencies Lack Processes to Ensure That They Spend or Award Proposition 56 Grants for the Purposes Established in Law
Some of the state agencies that receive Proposition 56 funding have insufficient safeguards over the use of those funds. To determine if the agencies we reviewed were using funds appropriately, we reviewed their policies and procedures for awarding Proposition 56 funds and for monitoring the use of those funds by grant recipients. We found that some agencies’ processes were not sufficient to ensure that funds were being used for their intended purposes. We describe such processes as deficient safeguards. Table 1 shows that five of the 12 programs we reviewed had deficient safeguards over their use of Proposition 56 funds.
State Entities Did Not Adequately Oversee the Awarding and Spending of Some Proposition 56 Grant Funds
|Grant Selection||Grant Monitoring|
|Fiscal YearS 2017–18 and 2018–19 Proposition 56 Appropriations
|Established a process for selecting applications for grant funds based on criteria in the law||Created a process to determine whether funds were spent in accordance with the law|
|Health Care Services||CBAS Program||2||X||NA*|
|Physician Services Supplemental Payments||825||†||✓|
|Dental Services Supplemental Payments||350||†||✓|
|Women’s Health Supplemental Payments–Pregnancy Termination||20||†||✓|
|Home Health Rate Increase||28||†||✓|
|Pediatric Day Care Rate Increase||7||†||✓|
|Physicians and Dentists Loan Repayment Act Program||220||X||X|
|Justice||Tobacco Grant Program||74||X||X|
|Public Health||Tobacco Control Program||309||X||✓|
|UC||Tobacco Related Disease Research Program||143||✓||✓|
|Graduate Medical Education||90||✓||✓|
Source: State law, the U.S. Government Accountability Office’s Standards for Internal Control, State Controller’s financial records, and interviews and documentation from each of the entities listed.
* It was not possible to assess whether these funds were spent for their intended purpose because neither Proposition 56 nor Health Care Services established requirements for the use of the funds beyond ensuring timely access, limiting geographic shortages, and ensuring quality of care.
† These programs provide additional payments to Medi‑Cal providers for delivering certain preselected services. According to Health Care Services’ chief financial officer, it automatically applies the additional payments for those services and does not require the providers to engage in an application process.
= Adequate safeguards= Deficient safeguards
For example, Justice did not effectively ensure that the grants that it awarded would be used exclusively for the requirements described in state law. State law requires Justice to distribute its Tobacco Grant Program funds to law enforcement agencies to support and hire front‑line law enforcement peace officers to reduce the illegal sales of tobacco products, particularly illegal sales to minors. These activities include enforcing tobacco‑related laws, increasing investigative activities, and reducing illegal sales. However, Justice did not establish a process for awarding Proposition 56 funds that ensured that the grants it selected were used exclusively for these requirements. Specifically, for fiscal year 2017–18, Justice used a grant evaluation form that assessed whether a grant application included certain activities, some of which are permitted by Proposition 56. However, the form did not disqualify applications that included activities other than those permitted by Proposition 56. Further, the potential activities described on the form included education and outreach, which are not activities permitted by Proposition 56 for Justice’s use of these funds. For fiscal year 2018–19, Justice’s grant evaluation form was even less detailed. It required reviewers to indicate whether the activities in the application were within the scope of Proposition 56, but did not define what Proposition 56 required. In both years Justice lacked any formal policies or guidance accurately describing what activities were allowable under Proposition 56. In addition, Justice communicated inaccurate information about the program to potential applicants. The website for Justice’s Tobacco Grant Program incorrectly stated that applicants were also allowed to use these funds for public education outreach and media campaigns, instead of exclusively for enforcement of tobacco‑related laws, as Proposition 56 requires.
As a result of these weaknesses in its processes, Justice awarded nine of the 10 grants we reviewed to projects that included activities that did not comply with the requirements of Proposition 56. For example, it gave one grantee funds for providing tobacco and nicotine education programs to students, and it provided another with funds to implement tobacco cessation and intervention services. However, although Proposition 56 allocates funds to Education for school programs to prevent and reduce the use of tobacco and nicotine products by young people, it requires the funds it allocates to Justice to be used for law enforcement purposes. Justice’s Tobacco Grant Program manager (program manager) stated that Justice’s process for awarding these grants consisted of three levels of review, and it assumed that this review was sufficient to ensure that grant applications were in compliance with the requirements of Proposition 56. However, because the process did not evaluate whether applications were exclusively for the activities permitted by Proposition 56, Justice’s staff apparently did not consider those requirements when approving the grants.
By awarding Proposition 56 funds for activities outside the legal requirements for its use, Justice reduced the resources devoted to enforcing tobacco laws and preventing the inappropriate sale of tobacco products. Inappropriate sales of tobacco products can cost the State millions of dollars in tax revenue. For example, in 2010 the Office of the Attorney General reported that a three‑year investigation by Justice had uncovered tobacco smuggling and tax evasion schemes that cost the State more than $80 million in uncollected tobacco taxes. Increasing the resources available to prevent this could result in increased revenue in addition to furthering efforts to reduce youth smoking.
Health Care Services has also awarded funds that did not address the priorities state law establishes for their use. In fiscal year 2018–19, the State allocated Health Care Services a total of $220 million in Proposition 56 funds to pay the student loans of certain physicians and dentists. The loan repayment program is intended to encourage dentists and physicians to maintain or increase their Medi‑Cal patient caseloads. In exchange for a five‑year obligation to maintain a caseload of 30 percent or more Medi‑Cal patients, Health Care Services will repay up to $300,000 of an individual’s student loans. State law establishes three priorities for this program: ensuring timely access to care, ensuring quality care in the Medi‑Cal program, and limiting geographic shortages of services. However, although Health Care Services’ application review process for the program assigned a certain number of points to applicants located in areas with shortages of health professionals (health professional shortage areas), it assigned twice as many points to a review of the applicants’ personal statements. Health Care Services’ failure to require that grantees be located in geographic shortage areas undermined one of the priorities that state law establishes for the use of these funds.
As a result, many of the primary care physicians and dentists that Health Care Services selected for the program are not located in areas that the federal government defines as health professional shortage areas. The federal Health Resources and Services Administration identifies several different types of health professional shortage areas, including geographic areas that have a shortage of primary care, dental, or mental health care providers either for the entire population within that area or for a specific group within that area, such as individuals with low income. However, according to Health Care Services’ deputy director of health care financing (deputy director of financing), Health Care Services wanted to award loan repayment program funds to providers in as many different geographic areas and specialties as possible, and therefore did not require applicants to operate in geographic shortage areas. According to data that the deputy director of financing provided, 79 of the 117 primary care physicians Health Care Services selected for participation in the loan repayment program during fiscal year 2018–19 were not located in health professional shortage areas. In total, Health Care Services agreed to repay $18.5 million in loans for these 79 primary care physicians.
Consequently, Health Care Services spent fewer funds to support health care providers in health professional shortage areas. The lack of health care professionals in these areas has a significant impact on Medi‑Cal beneficiaries. In our March 2019 audit report titled Department of Health Care Services: Millions of Children in Medi‑Cal Are Not Receiving Preventive Health Services, Report 2018‑111, we concluded that Medi‑Cal beneficiaries do not have adequate access to the providers they need in many parts of California. For example, because of health care provider shortages, Health Care Services approved access standards in certain parts of the State that allow managed care plans providing services to Medi‑Cal beneficiaries to require children to travel as far as 85 miles to see their primary care physician.
By prioritizing program applicants in these health professional shortage areas, Health Care Services could have better addressed this need. In fiscal year 2018–19, it denied the applications of 104 primary care physicians located in such areas, while granting funds to the 79 who were not in a shortage area. Figure 8 shows the locations of primary care physician loan repayment applicants in health care provider shortage areas who were denied funds and those applicants not located in health professional shortage areas who were awarded funds. Although Figure 8 does not take into account all of the other factors that Health Care Services considered when selecting applicants, it does demonstrate that Health Care Services did not award funds to numerous applicants who could have helped address the need for providers in health professional shortage areas.
Health Care Services Awarded Proposition 56 Funds for Fiscal Year 2018–19 to Primary Care Physicians Who Were Not in Areas With Provider Shortages
Source: State Auditor analysis of data from Health Care Services, the U.S. Health Resources and Services Administration, and the U.S. Census Bureau.
Note: Due to their close proximity, not all applicants are visible on the map.
In addition, Health Care Services also selected 121 physician specialists for the loan repayment program, agreeing to repay a total of $28.4 million of their student loans. However, according to the deputy director of financing, Health Care Services’ selection process did not assess whether these specialists would address shortages. Although Health Care Services used the federal designations to determine whether primary care physician and dental applicants were located in geographic areas with shortages of primary care physicians and dentists, the deputy director of financing confirmed that Health Care Services has not established a process to determine whether specialist applicants are located within a shortage area. As a result, it cannot determine if the specialists it awards funds are meeting one of the fundamental priorities of the loan repayment program.
We also identified deficiencies in the safeguards that Health Care Services has established over the award of funds for its CBAS program. Health Care Services, the California Department of Aging (CDA), and Public Health jointly administer the CBAS program under an interagency agreement. The CBAS program provides services to elderly individuals and adults with chronic health conditions or disabilities who are at risk of needing institutional care and who are enrolled in Medi‑Cal managed care plans. According to CDA’s website, about 259 CBAS centers operate statewide. CBAS’ services include, among other things, professional nursing; personal care; and physical, occupational and speech therapies. For fiscal year 2018–19, the Legislature allowed Health Care Services to allocate up to $2 million of its Proposition 56 appropriation for one‑time funding to CBAS centers based on criteria that include, but are not limited to, their need for funds based on operating costs in high‑cost areas of the State.
Health Care Services’ method of awarding these funds did not ensure that the State received a benefit from their use. According to the chief of Health Care Services’ Home and Community‑Based Services Section (section chief), Health Care Services did not establish a formal process to review the funding requests it received from the centers. Instead, it used information that the centers self‑reported on the amount of funds they needed, awarded the full amounts requested by those centers located in the City and County of San Francisco, and divided the remaining funds proportionally based on the requested amounts of those centers located in the 10 other counties in the State with the highest costs of living, regardless of need. Health Care Services’ section chief indicated that it was not necessary to establish policies and procedures for this process because it was a one‑time funding allocation and required minimal direction. Because it did not require centers to demonstrate a need for funds or require those funds to be spent for specific purposes, Health Care Services could not explain what benefit the State received from the funds that it granted through this program. Neither Proposition 56 nor Health Care Services defined how these funds could be spent, and as a result Health Care Services did not monitor how they were used. The lack of effective grant management increases the likelihood that the funds were spent for purposes that did not contribute to Health Care Services’ goals.
Two agencies also failed to establish formal processes to ensure that they award sufficient funding to address tobacco‑related disparities. State law requires both Public Health, with respect to the portion of the Proposition 56 revenues funding its Tobacco Control Program, and Education, through its Tobacco‑Use Prevention Education (TUPE) program, to ensure that at least 15 percent of these Proposition 56 funds are used to accelerate and monitor the rate of decline in tobacco‑related disparities with the goal of eliminating them. Tobacco‑related disparities are differences in the use by or effects of tobacco on different groups of people. They include using tobacco products at a higher rate, experiencing greater secondhand smoke exposure, being disproportionately targeted by the tobacco industry, or having higher rates of tobacco‑related diseases compared to the general population.
Neither Public Health nor Education could demonstrate that they had formalized a process to ensure that they awarded at least 15 percent of those Proposition 56 funds to address disparities during the period we reviewed. Public Health’s assistant branch chief stated that it has been working to reduce tobacco‑related health disparities for many years, and it did not seem necessary to formalize the processes it uses to ensure that it awards sufficient funding. However, in response to our inquiries, he stated that Public Health has begun work to create written policies and procedures for meeting this requirement. Similarly, Education failed to create a formal process to ensure that it awarded 15 percent of its Proposition 56 funds for disparities. The administrator for Education’s TUPE office indicated that to expedite payments to grantees, Education increased payments to existing grants and as a result, the grant award language for that first funding year was not tailored specifically to the requirements of Proposition 56. The administrator also stated that Education did not subsequently verify that 15 percent of the funds were spent to accelerate and monitor the rate of decline in disparities. Although she stated that in fiscal year 2018–19 Education amended the agreements for these grants to require additional information in the grantees’ progress reports, it did not award any additional grants in that year. Without formal policies and procedures to award at least 15 percent of its Proposition 56 funds to address disparities, agencies increase their risk of failing to apply the amount of funding required by law to accelerate and monitor the rate of decline in tobacco‑related disparities.
Some State Agencies Have Not Sufficiently Monitored Grantees’ Use of Proposition 56 Funds
Two state agencies we reviewed had not implemented adequate processes to monitor whether grantees spent Proposition 56 funds in accordance with the requirements Proposition 56 establishes. Because state agencies should monitor the use of funds after grantees receive them, we reviewed the safeguards each entity created to ensure that the grantees use the funds appropriately. Depending on the nature of a grant, these safeguards could consist of ensuring that the grantee’s eligibility to receive the funds has not changed, verifying whether the grantee has met the terms of the grant agreement, and reviewing costs charged to the grant to ensure that those costs are allowable, necessary, and reasonable. In the absence of such safeguards, the State has little assurance that grantees are using Proposition 56 funds in the way in which it intended.
Nonetheless, Health Care Services has not established a formal process to assess whether the health care providers to whom it awards funds remain eligible to participate in the loan repayment program. As part of the application process, Health Care Services reviews the percentage of Medi‑Cal patients that applicants report serving and the percentage that they propose serving. Its contract with program participants allows them to self‑report the percentage of Medi‑Cal patients in their caseload during their five‑year obligation to provide services; however, according to the deputy director of financing, Health Care Services has not yet formalized a process to verify the caseload information the participants provide. If participants’ caseloads fall below 10 percent of their proposed Medi‑Cal caseloads for two consecutive years, the contract allows Health Care Services to cease making loan payments. However, without a process in place to verify this information, participants have little motivation to accurately report if their Medi‑Cal caseloads drop below the required percentage.
Without assurance that the information that participants report is accurate, Health Care Services may have made payments toward the student loans of participants who are not serving Medi‑Cal patients or are serving fewer such patients than agreed. After we discussed this concern with Health Care Services, the deputy director of financing indicated that as of September 2020, Health Care Services was working on formalizing a process to verify the caseloads that participants report.
During the fiscal years we reviewed, 2017–18 and 2018–19, Justice also lacked a formal process for monitoring how grantees spent Proposition 56 funds. Although Justice now has a formal process in place to verify that the costs it reimburses are consistent with grant agreements, its program manager stated that it created this guidance sometime after July 2019, more than a year after it awarded some of the Proposition 56 grants that we reviewed. In addition, Justice has not ensured that the grants it awards are to be used exclusively for purposes aligned with Proposition 56 requirements. As a result, although its process may ensure that grantees spend funds in accordance with their grant agreements, it does not ensure that those expenditures comply with the requirements that state law establishes for the funds.
Most State Agencies Did Not Meet the Reporting Requirements to Publish Information on the Proposition 56 Funds They Received and Used
Most of the state agencies that received Proposition 56 funds did not meet the associated reporting requirements related to the receipt and use of those funds, limiting the information available to the public about the use of this tax money. State law requires each state entity that receives Proposition 56 funding to annually publish on its website how much money it receives from the tobacco tax fund and how that money was spent. This information allows the public to monitor how the agencies use the taxes the public pays. Although Proposition 56 does not define a specific date by which agencies must publish this information, we determined for the purposes of our review whether agencies had published information for fiscal years 2017–18 and 2018–19 by July 2020, one year after the end of fiscal year 2018–19 and two years after the end of fiscal year 2017–18.
Table 2 shows that by July 2020, four of the six state agencies that we reviewed had not reported either the amount of Proposition 56 funds they had received or the amount they had used in fiscal year 2018–19. Further, three of those agencies had not yet reported the amounts they received or spent in fiscal year 2017–18. The agencies that reported information for fiscal year 2017–18 did not do so in a timely manner: they provided it more than 12 months after the end of the fiscal year in which they received the funds.
Some Entities Did Not Disclose Their Receipt and Use of Proposition 56 Funds in a Timely or Complete Manner
|Fiscal Year 2017–18||Fiscal Year 2018–19|
|Entity||Amount Received||Use of Funds||Date Posted||Amount Received||Use of Funds||Date Posted|
|Health Care Services||X||X||–||X||X||–|
|UC||✓||✓||May 2020†||✓||✓||April 2020|
|Justice||✓||✓||July 2019||✓||✓||June 2020|
Source: State law, the websites as of July 2020 for each entity listed, and documentation from each of the entities listed.
* Public Health posted the amount of Proposition 56 funds budgeted for its tobacco control programs. However, it did not post the amounts for the state dental program or the local law enforcement programs to prevent the sale of cigarettes and tobacco products to minors, nor did it post the amounts of funds it actually received or spent.
† UC updated its webpage to publish the required information after we brought the issue to its attention.
The agencies attributed the reporting problems we identified to factors such as staff turnover, waiting for the State’s accounting system to close for the year, and a lack of a due date in the law. However, we did not find these reasons compelling. Although Proposition 56 does not identify a due date, the law does specify that the agencies provide the required information to the public annually. It is therefore unreasonable for agencies to assume that they have an unlimited amount of time to do so. The State Controller generally requires agencies to submit year‑end financial reports within four months of the end of the fiscal year, which occurs on June 30. Further, agencies could publish information for the public’s use before the State’s accounting system closes for the year by using the preliminary data that they provide to the State Controller and then, if necessary, updating that information at a later date. By failing to provide information in a timely manner or at all, the agencies limited the public’s ability to monitor their spending of Proposition 56 funds and reduced the relevance of the information they ultimately provided.
Further, agencies interpreted the Proposition 56 reporting requirements differently and consequently reported information that was not consistent with the requirements in law or with each other’s reporting. For example, Public Health published information on some of the Proposition 56 funds that it was budgeted to receive. However, it did not provide information on the actual amounts that it received, omitted two of its programs entirely, and did not publish the amount of Proposition 56 funds that it spent. In contrast, CDTFA chose to post only its Proposition 56 spending, which the chief of its financial operations bureau asserted is equivalent to the amount that it receives and is the information of primary interest to its stakeholders. These variations in the agencies’ reporting reduce the ability of the public to easily understand and compare information from different agencies. Some agencies attributed the differences we identified to their respective interpretations of the requirements in law. However, the law clearly requires agencies to report both the amounts of Proposition 56 funds that they have received and the amounts that they have spent.
CDTFA, Education, Health Care Services, Justice, Public Health, and UC
To provide the public with relevant information and ensure the level of accountability that state law intends, each state entity that receives Proposition 56 funds should publish the following information on its website by April 2021 for fiscal years 2017–18 through 2019–20, and within six months of the end of each fiscal year, beginning with fiscal year 2020–21:
- The amount of Proposition 56 funds received by each program it administers.
- The amount of Proposition 56 funds spent by each program it administers.
- The amount of Proposition 56 funds obligated for future expenditures by each program it administers.
- Any corrections to the information it reported in previous fiscal years.
To increase the accuracy of its calculation of the tax rate for other tobacco products, CDTFA should take the following steps to update its methodology for calculating the tax by March 2021:
- Include nonpremium cigarettes in its calculation of the average manufacturer wholesale cigarette price.
- Determine the current wholesale markup rate for cigarettes and use this rate when calculating the tax rate for other tobacco products.
To ensure that the other tobacco products tax rate accurately reflects changes in the wholesale price of cigarettes, CDTFA should enact a policy to obtain the current wholesale markup rate for cigarettes no less than every three years and to incorporate this number in its calculation of the tax rate.
To ensure that it applies sufficient funding to address tobacco‑related health disparities, by June 2021, Education should establish a formal procedure for meeting the requirement that it spend at least 15 percent of the Proposition 56 revenues funding its TUPE program to accelerate and monitor the rate of decline in tobacco‑related health disparities.
Health Care Services
To ensure that the State benefits from its use of Proposition 56 funds, Health Care Services should, by June 2021, implement a policy to establish formal processes for granting all funds, regardless of whether a program receives a one‑time allocation or is ongoing. The policy should require sufficient criteria to ensure that the funds awarded provide the benefit intended by the program.
To ensure that it awards funds to applicants who address the need for providers in health professional shortage areas, Health Care Services should amend its application selection process to require by June 2021 that all participants practice in geographic areas that have shortages of such health care professionals, and annually verify that participants continue to practice in such areas.
To ensure that participants are serving the agreed‑upon Medi‑Cal patient caseloads, Health Care Services should finalize its formal process by June 2021 to verify the caseload percentage that participants self‑report.
To ensure that it awards Proposition 56 funding in accordance with the requirements in state law, Justice should implement a formal grant application review process by June 2021 that ensures that it does not award Proposition 56 funds for purposes—such as education and outreach—that are not described in the law governing its use of funds.
To ensure that it applies sufficient funding to address tobacco‑related health disparities, by June 2021, Public Health should establish a formal procedure for meeting the requirement that it award at least 15 percent of the Proposition 56 revenues funding its Tobacco Control Program to accelerate and monitor the rate of decline in tobacco‑related health disparities.
Other Areas We Reviewed
In addition to the issues we describe in the Audit Results, we also reviewed the distribution of Proposition 56 funds, state agencies’ use of Proposition 56 funds for administrative costs, the methods CDTFA used to report required information, and the oversight provided by the Tobacco Education and Research Oversight Committee (TEROC) over certain tobacco tax programs. Portions of our reviews in these areas resulted in recommendations that we do not present in previous sections of the report.
Distribution of Proposition 56 Funds
As the Introduction describes, state law directs CDTFA to determine the amount of certain tax revenues lost due to lower cigarette or tobacco consumption as a result of Proposition 56’s cigarette and tobacco tax increase, and it directs the State Controller to replace those revenues. The legislative analysis for Proposition 56 states that by increasing taxes on tobacco products, Proposition 56 reduces tobacco sales and thus it decreases the amount of money generated by those earlier taxes. CDTFA refers to the portion of Proposition 56 funding it allocates to the funds for other taxes as the backfill. We examined CDTFA’s process for calculating the backfill and evaluated whether the backfill amounts during fiscal years 2017–18 and 2018–19 were reasonable. We found that the model that CDTFA used to calculate the backfill allocations was reasonable and that the backfill amounts it requested the State Controller to transfer for fiscal years 2017–18 and 2018–19 matched the model.
We also examined the State Controller’s policies and procedures for allocating and transferring Proposition 56 funds to state agencies, and we determined whether those allocations and transfers were appropriate for fiscal years 2017–18 and 2018–19. We identified a discrepancy between the amounts that should have been transferred in May and June 2019 and the amounts that the State Controller transferred to the agencies; the actual amounts transferred were smaller than they should have been. According to the State Controller’s consulting section supervisor (section supervisor), the State Controller used an incorrect fund balance in the May and June 2019 calculations. According to the section supervisor, the State Controller transferred the missing funds in the following transfers, which occurred in June 2019 and November 2019. The State Controller subsequently added instructions to the spreadsheet that it uses to calculate the transfers in order to prevent the mistake from happening again. We found that these delayed transfer amounts did not have a material effect on the Proposition 56 transfers overall and that the State Controller now has appropriate processes in place to ensure that it transfers Proposition 56 funds appropriately.
For fiscal year 2017–18, the budget act appropriated specific amounts for the four entities that receive a percentage of Proposition 56 revenue: Health Care Services, Public Health, Education, and UC. However, some of those appropriations were greater than the agencies’ proportional share of the actual revenue collected. Further, the variable allocations for Public Health and Education were transferred into a single fund. Public Health subsequently spent or obligated nearly all of the fiscal year 2017–18 funds it was appropriated, which was $2.5 million more than its proportional share of the revenue. As a result, there are insufficient funds to pay Education the percentage of Proposition 56 funds that it should have received for fiscal year 2017–18.
However, Education failed to spend or obligate the full amount of its own appropriation, and its authority to spend those funds subsequently expired. According to the section supervisor, any funds that are not spent remain in the fund. Beginning in fiscal year 2018–19, Finance created separate funds for the two entities and provided spending authority for the newly created funds based on the amounts transferred into the funds. A manager in Education’s fiscal and administrative services division stated that Finance intends to transfer the unspent funds from fiscal year 2017–18 to the new fund created for Education. However, even if Finance restores authority to spend the full amount of the funds remaining, there are insufficient funds in the account for Education to spend its proportional share.
To obtain its full share of the fiscal year 2017–18 Proposition 56 revenues, Education should negotiate with Finance and Public Health to ensure that it receives the full amount of its proportional share of the fiscal year 2017–18 Proposition 56 funds.
Management of Administrative Costs
State law prohibits state and local entities from spending more than 5 percent of the Proposition 56 funds they receive on administrative costs. For fiscal years 2017–18 and 2018–19, we determined the total amount of Proposition 56 funds that each entity spent on administrative costs and then compared them to the total amount that each entity was allocated for all of the programs using Proposition 56 funds it administered. Based on that information, we found that none of the state agencies we reviewed exceeded the limit on administrative costs.As described in the data reliability section of this report, Public Health was unable to provide us with the necessary information for fiscal year 2017–18 to confirm whether the data that it had provided for that year were complete and accurate. Therefore we could not determine whether Public Health’s administrative costs were less than 5 percent for that fiscal year. However, Public Health did not have policies or procedures in place to monitor the administrative costs of its Proposition 56‑funded Office of Oral Health. Although the administrative costs for this program did not exceed 5 percent during the audit period, Public Health risks doing so in the future in the absence of policies and procedures. Public Health provided evidence that it is currently developing such policies and procedures, but did not provide a timeline for completing them.
To reduce the risk of exceeding Proposition 56’s limit on the use of funds for administrative costs, Public Health should, by June 2021, develop and implement a procedure for verifying that its combined administrative costs for its Proposition 56‑funded programs do not exceed 5 percent.
Required Reporting by CDTFA
Source: CDTFA’s website.
To provide public accountability for the Proposition 56 funds it receives, CDTFA should publish on its website information about the Proposition 56 funds that it receives and spends in a manner that allows the public to easily find the information and that does not restrict the public’s access.
Required Elements of TEROC’s
Annual Report to the Legislature
- The number and amount of tobacco education programs funded by the Health Education Account created by Proposition 99.
- The fund balances and amount of funds appropriated to, but unspent by Public Health, Education, and UC.
- A description and assessment of certain programs funded by Propositions 99 and 56.
- Recommendations for necessary policy changes or improvements for tobacco education programs.
Source: State law.
Oversight Provided By TEROC
TEROC is a legislatively mandated advisory committee charged with overseeing the use of certain portions of the Proposition 99 and Proposition 56 tobacco tax revenues. According to the assistant branch chief of Public Health’s Tobacco Control Program, which provides TEROC with administrative support, TEROC’s expenses are absorbed through the Tobacco Control Program’s budget and personnel costs, and it uses funds from the taxes imposed by Proposition 99 and Proposition 56 for its meeting, equipment, and staffing expenses. He indicated that TEROC spent $144,000 and $149,000 for fiscal years 2017–18 and 2018–19, respectively. State law directs TEROC to advise the Legislature on relevant public policy and certain tobacco tax funds used by Public Health, Education, and UC. Specifically, it requires TEROC to provide an annual report to the Legislature on the elements in the text box (annual report). Further, every two years, it must provide a comprehensive master plan for implementing the tobacco education programs throughout the State, including certain tobacco‑related programs that Public Health, Education, and UC administer.
We found that TEROC has not provided the required annual reports to the Legislature. TEROC’s committee chair stated that it does not provide the annual report, but he asserted that Finance already produces the required financial information and that if TEROC were to compile the data, it would duplicate Finance’s work. He also stated that TEROC frequently provides recommendations to the Legislature on necessary policy changes. However, he acknowledged that although Finance annually provides information about Proposition 99 funds, it does not provide similar information for Proposition 56 funds. In addition, the recommendations TEROC has provided do not constitute an annual description and assessment of the programs funded by the Health Education Account tobacco tax funds, as the law requires. Without this information, the Legislature lacks a useful resource for informing its decisions about tobacco tax‑funded programs.
Further, TEROC has created master plans every three years instead of every two years, as required. TEROC’s committee chair once again referred to its recommendations to the Legislature on necessary policy changes and stated that since the 1990s, it has been TEROC’s practice to submit its master plan every three years. The committee chair stated that the Legislature has not questioned the frequency of the master plans; that to return to creating a master plan every two years would have increased Proposition 99 expenditures; and that as tobacco sales fell, the programs relying on those funds saw a decrease in available funding. He indicated that TEROC felt pressured not to increase expenditures because it was aware of the decline in Proposition 99 revenues. However, the assistant branch chief of Public Health’s Tobacco Control Program indicated that TEROC did not have a budget limit. Although the committee chair stated that TEROC had no clear directive from the Legislature to return to creating a master plan every two years, the law clearly states that TEROC must submit the plan to the Legislature once every two years.
To ensure that the Legislature has the knowledge necessary to make informed decisions about tobacco tax‑funded programs, TEROC should produce the annual report each year, as state law requires.
To ensure that it is meeting the Legislature’s expectations, TEROC should either provide the master plan to the Legislature every two years, as state law requires, or seek legislative change to reduce the frequency with which it is required to produce the master plan.
We conducted this performance audit in accordance with generally accepted government auditing standards and under the authority vested in the California State Auditor by Government Code 8543 et seq. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on the audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives.
ELAINE M. HOWLE, CPA
California State Auditor
January 5, 2021